In case you have not heard, interest rates are expected to start rising soon, and as we know, this will weigh on the returns of bonds. But what about stocks? Some stocks, such as utility stocks, are more sensitive to interest rates than others. Hence, when rates rise, stocks with a high, inverse level of sensitivity to interest rates are likely to underperform the broader market. As a solution to this issue, PowerShares has devised a new ETF that reduces its holdings of those rate-sensitive stocks, but has done so by adding that twist to its popular low volatility ETF, the S&P 500 Low Volatility Portfolio ETF (SPLV).
The new PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio ETF (XRLV), which debuted on April 9, tracks the S&P 500 Low Volatility Rate Response Index, provides exposure to low-volatility stocks that have performed adequately during rising rate environments. Thus, XRLV may be a good option for investors looking to maintain market exposure while limiting volatility and reducing interest rate risk.
XRLV offers a “two-factor solution” for investors looking for low-volatility combined with low interest rate-risk equity exposure. The S&P 500 Low Volatility Rate Response Index begins by reducing the S&P 500 down to the 400 stocks with the greatest positive exposure to the 10-year treasury yield – this is the first factor. This step eliminates those 100 stocks with the highest negative exposure to interest rates over the past 60 months (i.e. when rates rise, these stocks have fallen, and vice-versa).
For the second factor, the remaining 400 stocks are reduced to the 100 with the lowest absolute level of volatility over the past 12 months. These 100 stocks constitute the S&P 500 Low Volatility Rate Response Index and the holdings of XRLV, both of which are weighted so the companies with the lowest volatility are given the largest weights.
“The combination of rising volatility and interest rates can have an adverse impact on equity prices, highlighting the need for tailored risk management solutions,” said Dan Draper, Head of Invesco PowerShares, in a statement. “XRLV is designed to minimize the impact of rising volatility and higher interest rates on our clients’ portfolios. We see this as a strategic addition to our existing suite of PowerShares low volatility solutions.”
Holdings and Low Volatility Only
As of April 10, XRLV’s holdings were concentrated in the financial (35.16% of total holdings) and industrial (19.02%) sectors. Its largest individual holdings included Travelers (TRV), Republic Services (RSG), and Waste Management (WM), which ranged from 1.24% to 1.26% of XRLV’s holdings. Just under 72% of the fund’s holdings were large-cap, with a fairly even distribution between large-cap value (22.74%), large-cap blend (26.53%), and large-cap growth (22.67%) styles.
Compared to the PowerShares S&P 500 Low Volatility Portfolio (SPLV), the most significant difference is that XRLV does not have an allocation to utility stocks, whereas SPLV currently holds a 13% position in utility stocks. Performance of the indices underlying both of the ETFs, for the period ending 3/31/15, is below (source: us.spindices.com):
Despite the declining interest rate environment over the past 3-5 years, the Low Volatility Rate Response Index has outperformed the straight up Low Volatility Index. In addition, according to the S&P Indices website, the correlation between the two indices is 0.95. Hence, if you are a believer in the low volatility anomaly, and you believe that we are entering an environment of rising interest rates, then XRLV may be just the ticket.
You can find out more by visiting XRLV’s fund page at invesco.com or reviewing S&P’s page for the index.